Lorenzo Guglielmotti (Section O)

Short Analysis Assignment #2: Five-Forces Analysis for the Concentrate Industry (Cola
Wars Case)

(1)
1. Threat of new entry: low
It can be reasonably seen that the threat of new entrants is low due to the high entry barriers. In fact,
huge capital requirements are necessary to enter the U.S. carbonated soft drink (CSD) industry, there is
high competition in bottling process, which is a capital-intensive activity and involves high-speed
production and significant costs are required for advertising, promotion, market research and bottler
support. Analyzing the data showed by the case, Coke and Pepsi spent 234$ million and 136$ million
on advertising in 2009, respectively, and the expense for share point were 15,294$ and 15,456$.
In addition, the strategy to keep secret cola recipe make difficult the perfect imitation by new
competitors and brand identification and customer loyalty to incumbent products represent high barrier
to potential entrants because of the reputation advantage gained by Coke and Pepsi, which has been
built up over many decades.
Finally, during the latest years, the industry has lost part of its attractiveness: according to the statistics
the demand for CSD leveled off, losing share in favor of healthier and non-carbs drinks.

2. The power of Suppliers: low supplier bargaining power

The most valuable input in the making process of CSDs (concentrate) is provided by the soft drink
companies, whereas the other inputs (sweetener, flavor, caffeine, carbonated water, packaging) required
are commodities (non-differentiated) and easily available in the market to every producer.
Hence a large number of suppliers are available for the inputs supplied and the switching costs are low,
based on needs and costs, making limited the supplier bargaining power. In support of that, it can be
get that cost of goods sold is only 0.22$, representing 22% of the net sales for concentrate producers.
Moreover forward integration by suppliers is not a credible threat because it requires high costs to get
competitive and developed bottling and distribution channels.

3. Power of Buyers: low/weak bargaining power

The category of buyers in the CSD Industry is represented by many players.
The network of bottlers is fragmented and has limited negotiation power with concentrate producers:
in fact, Coke’s Master Bottler Contract and Pepsi’s Master Bottler Agreement granted the two
companies the right to determine concentrate price and other terms and conditions of sales with their
top bottlers,. Moreover, the two companies have franchise agreements with their existing bottlers
which prohibit them from taking on new competing brands for similar products.
During the last years, Coke & Pepsi integrated their value of chain buying significant percent of
national bottling companies: in 2009 Pepsi bought two of its biggest bottlers and Coca-Cola
Enterprises (CCE), independent bottling subsidiary, in 2009 Coke’s largest bottler (75% of Coke’s
North American bottle and can volume and logged annual sales for more than 21$ billion) was bought
by Coke in 2010.
In addition, Coke and Pepsi lowered the power of national fountain accounts entering Fast-food
restaurant business: Coke retained exclusively deal with Burger King and McDonald (the largest
national account in terms of sales), Pepsi with Pizza Hut (1978), Taco Bell (1986), KFC (1986).
Last, the final end consumer market is large and extremely fragmented, characterized by advertising-
sensitive customers, in which no one customer tends to have bargaining leverage.

4. Threat of Substitutes: low/medium.

The soft drink industry has large numbers of substitutes since many alternatives to CSDs exist (coffee,
milk, beer, tea, juices, bottled water, energy and sports drinks) and popularity of non-carbs continued to
grow (from 13% of U.S. non-alcoholic refreshment beverage volume up to 17%), due to the rising
inclination of the consumers towards healthier drinks in response to the growing linkage between CSDs
and issues such as obesity and nutrition. In addition, the customer switching costs are low (for example
if the price of coke increased significantly, customers might easily shift to other soft drinks). However
Coke and Pepsi reduced the threat by diversifying business non-CSD industries through the expansion
of their products portfolio: they introduced different diet brands and sports drinks, developed their
own versions of sweetener and introduced purified-water products. On top of that, by 2009 Pepsi and
Coke had 43% and 32% of the U.S. non-carbs market share, respectively.

5. Rivalry among Existing Competitors: low/medium

The soft drink industry is dominated by two major players, who have the majority of the market share:
Coke & Pepsi claimed a combined 72% of the U.S. CSD market’s sales volume by 2009 (duopoly),
followed by Dr Pepper Snapple Group (DPS), which in 2009 is expected to hold 16.4% of market
share, and Cott Corporation (4.9%). Therefore the CR4 analysis show clearly the industry high
concentration in which the four main competitors hold 93.3% of the market share.
However it can be noticed that companies compete on differentiation rather than pricing, disallowing
decline on profits and keeping the industry very profitable. In fact, according to the financial data ROE
of Coca-Cola and PepsiCo are 27.5% and 35.4% respectively, by 2009.

(2) Given the strengths of the other Industry Forces, the level of rivalry seems to be what we should
expect, since according to the Porter’s Five Forces model, the latter force is strongly influenced by the
formers: the weaker the forces, the weaker expected competitive intensity. There is an evidence that the
competition between the two companies is benign for the most part, focusing on non-price factors
such as lifestyle advertising and product innovation rather than on price. Even if Coke and Pepsi faced
price war during the 70s and 80s, then they preferred to differentiate their business in order to prevent
falls in their revenues.

(3) The force which is changing the most is the threat of substitutes, which is gradually intensifying. In
fact, according to the statistics, in the late 1990’s demand of CSDs leveled off: Cola market is dropped
from 71% in 1990 to 55% in 2009. In addition, looking at the annual change in market share between
2004 and 2009, on one hand Coke and Pepsi lost 3.5% and 5.5% of their share, while on the other
healthier product such as Nestlè Pure Life and Lipton Tea gained 32% and 5.9% respectively. The
reason of the decline in CSD consumption during the last 20 years is to research into a negative health
perception of CSD which has been enhancing, making consumers looking for healthier alternatives,
despite both the firms tried to face the dwindling through innovation and advertising. This perception
was reinforced by Fed Nutrition Guidelines in 2005 which state CSD’s as largest source of obesity in
American Diet.